Like many countries around the world, Asia’s third-largest economy has suffered a torrid year. By the end of September, India had recorded more than 6m Covid-19 infections, ranking second by number of cases after the US.
This was despite the government hastily implementing one of the world’s most stringent lockdowns in March to combat the spread of the virus — a move that not only failed to contain the pandemic but also ended up creating a humanitarian crisis, after hundreds of thousands of migrant workers were stranded.
Growth has taken a beating in the process. For the second quarter of 2020, real GDP growth was minus 23.9% year-on-year — among the sharpest declines seen among Asia’s major economies. There is no light at the end of the near-term tunnel either. The International Monetary Fund is predicting a real GDP contraction of 4.5% for India this year, versus growth of 4.2% last year. Growth is, though, expected to rebound in 2021/2022.
The bleak numbers are despite steps taken by the Narendra Modi-led government, as well as the Reserve Bank of India, to shore up confidence in the country.
It began in late March, when finance minister Nirmala Sitharaman announced a $22bn-equivalent relief package to tackle the Covid-19 outbreak, with the funds earmarked for food-related measures, healthcare and agriculture.
The central bank, meanwhile, offered monetary policy support by lowering the repo rate and the liquidity coverage ratio for banks, offering billions in relief for micro, small and medium-sized enterprises, and non-banking financial companies (NBFCs), and offering loan repayment moratoria.
All these measures got the nod of approval from markets.
But efforts have been sorely lacking on greater direct fiscal support to the economy. Fiscal stimulus has been limited at a paltry 1.2% of GDP so far, versus roughly 3% on average in other emerging markets.
“This is the biggest mistake India made: not offering enough fiscal assistance,” says Bangalore-based Kunal Kumar Kundu, India economist at Société Générale. “Of course, India doesn’t have the fiscal space, but this is not the time to be fiscally conservative — when job losses are rising and spreading from the informal sector to the formal sector, and when there is the real possibility of these job losses becoming permanent.”
India’s fiscal deficit is likely to rise to about 12.5% of GDP this year, driven mainly by lower revenue generation. But market watchers say fiscal support is critical at this juncture in the world’s second most populated country, as it is faced with the triple threat of waning demand, supply concerns and financial sector stress.
Kundu says the “mother of all problems” is lack of demand.
“Unless demand picks up and remains stable, it’s very difficult for the economy to recover,” he adds. “And this cannot be addressed by monetary policies. When the biggest problem is demand, it has to be tackled with a fiscal response. Other countries have done this, but not India, which is why consumer confidence has hit rock bottom and the economic contraction has been unprecedented.”
Prime Minister Modi’s government’s unwavering stance on limiting fiscal support will come at a steep price, warns Raghuram Rajan, former governor at the RBI and currently a professor of finance at the University of Chicago Booth School of Business. He reckons the strategy of not doing more today to conserve resources for a future stimulus is “self-defeating”.
“Government officials who hold out the possibility of a stimulus when India finally contains the virus are underestimating the damage from a more shrunken and scarred economy at that point,” Rajan wrote in a LinkedIn post in early September.
Some fiscal space is available for the Indian government if it chooses to use it to bring the economy back on track. But months after the coronavirus reared its head in the south Asian country, that support is still lacking, raising some key questions. Will that fiscal support come? If so, when? And what impact could this have?
Prudence in the time of crisis
To answer these questions, it’s imperative to go back in time to see how India ended up in such dire straits in the first place.
For some, the government’s issues go back to around the time of the global financial crisis. In December 2008, the government announced a fiscal stimulus package of about $4bn to spur domestic demand, boost infrastructure spending and give a fillip to exports, through a combination of farm loan waivers and tax cuts. It followed it up with a further $4.1bn relief measure the following year that focused more on setting up alternative financing channels for NBFCs and for more capital expenditure through infrastructure development.
As a result, the country’s fiscal deficit shot up from about 2.6% of GDP in 2007/2008 to about 6% the following financial year.
“The story of India’s fiscal issues really started there,” says Sreejith Balasubramanian, a Mumbai-based economist in the fund management division of IDFC Asset Management Company. “There were lots of big stimulus measures, after which the overall public sector deficit never managed to get back to the pre-GFC level.”
Since then, India has witnessed multiple economic woes, he tells GlobalMarkets.
In a few years, inflation rose and investment slowed drastically. Companies began to reduce their spending, with the government being forced to plug that hole. Household savings started to dip, eventually leading to a decline in consumption.
Banks then reined back some of their lending, paving the way for India’s NBFCs to step in to fill that financing gap. That, however, eventually culminated in rising non-performing loans (NPLs) at India’s banks, and the spectacular collapse of aggressive non-bank lender Infrastructure Leasing & Financial Services, whose subsidiaries defaulted onshore in 2018, creating a pall over the country’s financial industry.
“The balance sheets of various economic agents were under pressure,” says Balasubramanian. “The advantage from 2016/17 was that world growth started getting better. But India again couldn’t fully use that opportunity because of demonetisation and the introduction of the [goods and services tax], which affected supply chains and the trade balance, and then we had the NBFC crisis soon after. India did not enter Covid in a strong position.”
Balasubramanian reckons all this could have played its part in the Modi government not yet using all its fiscal tools to counter the impact of the pandemic. After all, if people were unable or unwilling to spend money, particularly in the initial days, over fears of the health crisis, parking more money in their hands would have only increased savings.
But he also adds that as the government’s debt to GDP ratio will definitely rise sharply this year as it combats the pandemic, it needs to be able to sustain this through medium-term growth. “That is where fiscal policy really has to come in to get the wheel moving soon.”
What ammunition has the government got? SocGen’s Kundu says there have been some talks of boosting investment in infrastructure and using a public-private partnership model to add momentum to the industry. However, no concrete plans have emerged yet.
He adds that another measure the government should focus on is a temporary wage-sharing scheme with micro, small and medium-sized enterprises that have been hit hard by the pandemic, to help tide them over during this difficult time.
“These are two important pillars: wage sharing and immediately starting infrastructure investments. It’s something that should have been done earlier, but can still be done now as the impact could be significant in the longer run.”
Gearing up
It’s not going to be easy, of course, for several reasons. One of them is simply revenue limitations at both the state and central governments. According to research by Standard Chartered, revenue shortfall at governments in India is estimated to be at 4.6% of GDP, which could possibly rise to 6%.
Anubhuti Sahay, head of south Asia economic research at Standard Chartered in Mumbai, tells GlobalMarkets that the revenue shortfall is a “very large constraint on how much the government can spend to drive demand”, given two of the international rating agencies have the sovereign on a negative outlook.
S&P Global Ratings affirmed India’s BBB- rating with a stable outlook in late September. But in early June, Moody’s downgraded the sovereign by one notch to Baa3, while maintaining a negative outlook. Later the same month, Fitch revised its outlook on the nation to negative from stable, while affirming its BBB- rating.
“India is in a tight spot,” adds Sahay. “The real economic impact of Covid will emerge only over a period of time; right now, the impact of the shock is still unravelling itself. Hence, the government and the RBI need to use their ammunition in a calibrated manner as the shock will continue to reverberate for some time.”
In his LinkedIn post, former RBI chief Rajan suggested India should borrow more “without scaring the bond markets”, while also putting in place direct cash transfers to the poorest households to help them deal with the health crisis.
He also recommended establishing a plan to deal with the “financial distress” that will hit the country once the various payment moratoria come to an end, including by setting aside enough resources to recapitalise state-owned banks dealing with bigger losses than expected.
Kundu adds that there were some initial talks in India about selling an international Covid-linked bond — like numerous other sovereigns and multilateral development banks have done globally — but those discussions died down.
Instead, Kundu reckons the RBI, headed by governor Shaktikanta Das, might opt for monetisation of debt, where the central bank will buy government bonds.
Indonesia, for one, opted for a similar approach this year, when Bank Indonesia agreed to a debt monetisation programme of about $40bn to help with the crisis recovery. As part of this, the central bank will buy about $28bn of Indonesian government bonds at zero return.
“Difficult situations call for difficult action,” says Kundu. “But if the Indian government really shows adequate commitment to fiscal prudence, then debt monetisation can be the way out.”
Whether the government will go down that route — and what other fiscal tools it will deploy — is yet to be seen. But the authorities need to quickly sharpen their tools — the clock is ticking.